Thursday, July 05, 2007

Korea moves towards IFC

...It may be late, but South Korea is finally getting serious about financial market reform. This week the National Assembly is expected to approve a significant overhaul of the country's financial system, with an eye to making it an international hub. That goal is a decade or more away but if they stay on track, the South Koreans may just have a chance.

The reform is sweeping. The biggest change will be a shift to "negative list" regulation from a "positive list" regime. Under a positive list, only financial products that are approved by regulators can be marketed. A negative list system allows any product that's not explicitly banned. In the U.S. and Britain, negative list regulation has allowed financial innovators to market a dizzying array of new products, from weather futures to exotic credit derivatives. In South Korea, the hurdles imposed by positive regulation have, for example, blocked the development of over-the-counter credit derivatives found in many other markets.

South Korea is also tearing down regulatory barriers to consolidation and rationalization within the securities industry. The reform legislation will allow brokers to offer one-stop shopping for a variety of products, from futures to options to asset management services. ...

For just one example of what all this will mean for the average investor, consider banking services. A provision in the reform clears the way for brokerages to access the electronic payments system used by the banks. This will finally allow South Koreans access to the same kind of brokerage deposit accounts Americans have been able to open for years now. ...

The reform effort has been a long time coming. The government of President Roh Moo-hyun developed two separate roadmaps since 2003 for turning South Korea into a financial hub. The first roadmap, released in late 2003, was criticized for being too gradualist, trying to position South Korea first as a niche player in asset management services and only later -- around 2020 -- as a global hub.

In 2005, a much more daring roadmap was released, which has spurred several important reforms, culminating in this week's legislation. Special credit is due to Prime Minister Han Duck-soo, formerly the minister of finance and economy, who has been especially vigorous in pushing for change.

South Korea's measure is being compared to the "big bang" reforms that rejuvenated a drooping City of London two decades ago. But the legislation alone won't do the trick. The U.K.'s big bang resulted from a broad tranche of liberalization of everything from financial markets to telecommunications that touched virtually every aspect of the business climate. South Korea, by contrast, still has a highly restrictive business climate. Lingering red tape associated with cross-border capital flows is just one serious challenge to Seoul's ambitions.

Reinventing a city as a financial market hub isn't a new idea, especially as competition in Asia intensifies. Malaysia enacted its own little big bang in March, easing capital controls and lifting restrictions on foreign ownership of banks. ...

Whether or not the Koreans succeed, the big boys in London, New York and Hong Kong can't afford to be complacent. South Korean policy makers are mustering the political will to overcome past policy mistakes in the name of boosting competitiveness....

This impinges on the discussion of fast versus slow reforms in India. The typical government bureaucracy likes to set itself decade-long timetables for any significant change, thus placing changes deep in the future after the present staff is safely out of the way. But such a strategy inhibits the possibility of achieving an IFC in India in two ways. First, cities like London and Singapore have a certain international finance ecosystem humming today and not ten years in the future. Achieving even a 0.1% market share in international financial services requires making a big move compared with where we are. Further, new players - like South Korea - are doing big bang reforms, which actually sound quite familiar to the reader of the MIFC report. The fact that they do this increases the competitive pressure upon India to move quickly and not slowly.

The Korean movement on moving to negative list regulation is particularly remarkable because Korea comes from a German/continental legal tradition where everything is written down. Compared with that, executing modern financial sector reforms in a supposedly "common law" place like India ought to be easier. While on this subject, see a skeptical piece in The Economist about the difficulties of functioning in South Korea.

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